What problems and opportunities are created by tax havens?

Abstract

1) Introduction Tax havens have attracted increasing attention and scrutiny in recent years from policymakers, as exemplified by the OECD’s initiatives to combat “harmful” tax practices (OECD, 1998, 2000, 2004). The interest in tax havens reflects their disproportionate role in the world economy, and in particular their centrality to many of the important current policy debates in taxation, including international tax competition (Slemrod, 2004; Hines, 2006, 2007) and tax avoidance activity by corporations (e.g. Desai and Dharmapala, 2006, 2008). This paper provides an overview of the theoretical and empirical insights from a growing scholarly literature that analyzes the consequences and determinants of the existence of tax haven countries. The paper begins with an analysis of the characteristics of countries that tend to be classified as tax havens. It focuses in particular on recent evidence (Dharmapala and Hines, 2006) that tax havens tend to have stronger governance institutions (i.e. better political and legal systems and lower levels of corruption) than comparable nonhaven countries. The popular image of tax havens is somewhat at variance with this picture, and emphasizes their role in facilitating tax evasion by individuals. Recent estimates that have been widely influential in policy debates suggest large revenue losses from haven-related evasion activities (e.g. Guttentag and Avi-Yonah, 2006). This paper argues, however, that careful scrutiny of these estimates suggests that they imply vast amounts of “hidden” wealth, and (if true) would have wide-ranging implications (many of dubious credibility) for many economic phenomena far beyond the arena of taxation. It appears more likely that evasion by individuals plays only a secondary role in generating tax haven activity. Consistent with this view, some tentative evidence is presented in the paper suggesting that the OECD’s recent initiative (promoting international information-sharing among tax authorities) has had little impact on financial sector employment and wages in a representative tax haven (Jersey). The most important policy questions surrounding tax havens thus appear to relate to their role in enabling tax planning by multinational corporations. Multinational corporations can use tax havens to reduce or defer tax liabilities to other countries, through the strategic setting of transfer prices (especially for intellectual property) and the strategic use of debt among affiliates. It is often argued that tax havens erode the tax base of high-tax countries by attracting these